Economic Substance Regulations in the UAE
Economic substance regulations are the new cabinet decision endorsed by the United Arab Emirates (UAE) ministry through the Cabinet Decision No.31 on 30th April 2019. As per the ESR, companies in the UAE are required to demonstrate the economic substance in the relevant activities they carry out within the UAE. The Regulations necessitate UAE onshore and free zone companies and other UAE business firms that carry out any of the “Relevant Activities” mentioned below to sustain a suitable economic presence in the UAE relative to the activities they embark on.
Following are the few pointers to be considered:
1. This regulation applies to all companies holding licenses from any economic department in UAE, any free zone companies including offshore companies.
2. This regulation does not apply to any companies where directly or indirectly 51% share are held by the Federal Govt or any Emirates Govt.
3. If the companies do any of the following 9 relevant activities detailed below, then it will fall under the purview of the regulation and needs to notify the authorities in the prescribed format provided by the government:
- Banking Businesses
- Insurance Businesses
- Investment Fund Management Businesses
- Lease Finance Businesses
- Headquarter Businesses
- Shipping Businesses
- Holding Company Businesses
- Intellectual Property Businesses
- Distribution and Service Centre Businesses
4. If any of your company is providing loans with interest to any connected party in UAE or outside UAE, then you might fall under relevant activity “Lease – Finance Business”.
5. Each company must self- assess if they fall under any of the above relevant activities on a “substance over form” basis.
6. ESR notification and Annual substance reporting must be submitted if the entity conducts the relevant activity to prove the economic substance.
7. Conduct Core Income-Generating Activities Within the UAE
The UAE ESR guidelines have listed specific tasks associated with each relevant activity called the core income-generating activities (CIGA). For example, the CIGA of the companies carrying out the relevant activity of the banking business is
- Raising funds, managing risk including credit, currency, and interest risk
- Taking hedging positions
- Providing loans, credit, or other financial services
- Managing capital and preparing reports to investors or government authority
To demonstrate the UAE Economic Substance Test, the employees of the company need to conduct the CIGA. However, it is important to note that the CIGAs of the company should be performed by the employees who are UAE residents.
8. Monitor and Manage Businesses from Within the UAE
The Economic Substance Test evaluates companies are directed and operated from within the UAE to ensure that they perform an adequate number of board meetings in the UAE. For each board meeting held in the UAE:
- a quorum of directors must be physically present in the UAE
- meeting minutes must be maintained and signed in the UAE
- executives attending the board meeting must have the necessary skills and expertise to discharge their contractual duties
However, a Holding Company Business is not required to be directed and managed in the UAE, unless the relevant licensing authority requires it.
9. Employ Full-time Staff in the UAE
To determine the Economic Substance Test in Dubai, organizations are obligated to employ an acceptable number of qualified full-time staff who must be physically present in the UAE and must be performing the CIGA. The ESR has the option to tally the directors as employees for the purpose of the Economic Substance Test.
On 10 August 2020, the UAE Cabinet of Ministers issued Cabinet Resolution No. 57 of 2020 (the “amended ES Regulations”) which abolished the original ES Regulations, along with the updated Guidance clarifying the amended ES Regulations (Ministerial Decision 100 of 2020 dated 19 August 2020).
10. The amendments include:
Change in the Definition of the Licensee The newly amended ESR Regulations define a Licensee as
(a) Juridical Persons that are persons with separate legal personality
(b) Unincorporated partnerships that are engaged in relevant activity in the UAE. Other entities that come under the definition of natural persons. Sole proprietors, trusts, and foundations no longer come under the scope of the ESR in the UAE. Such entities no longer need to file the notification to meet the Economic Substance Test in the UAE.
11. Revised Treatment for the Branch Companies
The ESR law has revised its previous compliance requirements set for the branches. The new guidelines as follows:
a. UAE branch of a UAE business: The UAE parent firm is required to submit an annual ESR notification and file an annual ESR Return (if applicable) regarding its own relevant activities and that of all its UAE branches.
b. UAE branches of a Foreign Business: The UAE branch of a foreign business does not come within the scope of the ESR provided its income is reported in the tax return of the foreign parent/head office.
c. A foreign branch of a UAE business: The UAE entities are not required to notify the relevant activities of its branches and demonstrate economic substance in the UAE. However, such companies should ensure that the foreign branch is subject to tax on its relevant income in the foreign jurisdiction.
12. New Amendment Exempts Certain Licensees
The amended ESR Law has granted the exempt status to certain entities which are,
- Entities that are tax residents outside the UAE
- Investment Funds
- Entities wholly owned by the UAE residents provided they are not part of any multinational group and only conduct the activities in the UAE
- The UAE branches of foreign parent company whose income is subject to tax in the jurisdiction of the foreign head office/parent firm
However, the ESR law still requires the exempt entities to file the annual UAE ESR notification, and submit documentary evidence to prove the exempt status. For filing the ESR notification, such entities can seek the assistance of the best ESR consultants in Dubai, UAE.
13. Resubmission of Annual ESR Notification
An annual ES Notification is required to be submitted within six (6) months from the end of the last relevant financial period. All the Licensees and Exempted Licensees that undertake a Relevant Activity (irrespective of whether the Licensee or exempt Licensee has earned income from the Relevant Activity during the financial period) are required to file a Notification in the ESR portal on Ministry of Finance’s website. For entities that undertake a “Relevant Activity”, they will also be required to submit a full ES Report within 12 months from the end of their financial year.
14. Who do the Regulations Apply to?
A “Licensee” under the Regulations is a natural or juridical (legal) person licensed by the competent licensing authority/authorities in the State to carry out a Relevant Activity in the UAE, including a Free Zone (including an offshore free zone) and a Financial Free Zone. The Regulations affect Licensees: — That makes revenue from 1 or more Relevant Activities. — For financial years starting on or after 1 January 2019.
A “licensee” falls under the Regulations mostly as a legal person that is registered by the respective licensing authorities in the Emirate to perform a “Relevant Activity” in the UAE. This includes all free zones together with offshore and financial free zones.
The Regulations affect Licensees:
- Private Company (Ltd)
- Public Company (Plc)
- Partnerships (Limited Liability Partnership, Limited Partnership & General Partnership)
- Non-Profit Incorporated Organization
- Any branches that include a UAE or foreign company or partnership
15. Amendments to ESR Administrative Penalties
If a licensee or an exempted licensee fails to file an ESR Notification, the FTA will impose a fine of AED 20,000 for non-compliance. The Licensees that submit inaccurate information will attract a penalty of AED 50,000. A penalty of AED 50,000 will be slapped on the entities failing to file ESR Return and failing to meet the ESR test. If the Licensee fails to submit the ESR Return and meet the ESR test in the subsequent year a penalty of AED 400,000 will be imposed.
All UAE entities are strongly recommended to assess or reassess whether and which of their activities fall within the scope of the Economic Substance Regulations, and how to ensure they can meet the Economic Substance Test in respect of each relevant activity. Failure to comply with the Regulations can result in penalties, spontaneous exchange of information with the Foreign Competent Authority (as defined in Article 1 of the Regulations), as well as other administrative sanctions such as the suspension, revocation or non-renewal of the entity’s trade license or permit.
How can our consultants help you?
1. Technical assessment on applicability of ESR to your company or group of companies
2. Filing notification to the relevant authority before above mentioned deadlines
3. Consultancy on how to meet Economic Substance Test
4. Submitting ESR returns on annual basis